What to Expect From the Fed's Minutes

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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With the U.S. economy still running below potential and the rest of the world presenting ample challenges to growth, this week's release of minutes from the Federal Reserve's July policy-making meeting should garner a lot of interest among economists and market participants. I see five areas where the minutes can provide insight into how officials perceive the balance of risks and what actions they might take.

Jobs and wages. The labor market is looking much stronger after a disappointing reading for the month of May, with employers adding plenty of jobs, wage growth picking up and the unemployment rate staying relatively low. This suggests that slack is disappearing, but with one important caveat: The labor-force participation rate is edging up from near multi-decade lows, which is good news, suggesting that the economy has not yet reached full employment (the point beyond which inflation tends to become a problem). What we don't know -- and where the minutes might provide some clues -- is how far away Fed officials think the full-employment target is.

Productivity. U.S. workers' output per hour has been in a slump. This has contributed to the divergence between a robust labor market and the broader economy, where growth remained frustratingly low in the first six months of this year. Economists offer various explanations for the poor productivity performance, ranging from measurement slippages to much more consequential long-term forces. In the minutes, Fed officials might provide some clues, albeit far from decisive.

Low inflation. More than seven years into the economic recovery, the Fed still hasn’t reached its 2 percent inflation target. The minutes may shed light on how far officials are willing to go in embracing the possibility that this is much more than a cyclical shortfall, and that deeper secular and structural factors -- including international disinflationary influences and changes in both the monetary transmission mechanism and wage formation process -- may be involved. As recent comments by San Francisco Fed President John Williams highlighted, there is also some discussion -- albeit quite controversial -- about whether the Fed should increase its inflation target to mitigate the persistent risk of deflation.

External threats. Fed officials are undoubtedly relieved that the U.K. vote to leave the European Union hasn’t severely disrupted Europe's economy and financial markets. It's still early days, though, for what promise to be protracted negotiations between the U.K. and its European partners, with potential economic, institutional and political repercussions. With recent growth numbers signaling caution in both Europe and Japan, the Fed will have to keep a close eye on spillovers from what remains a fragile global economy. What is not clear, however, is the weight that the Fed places on international influences relative to domestic ones. The minutes may help in this regard.

The effectiveness of Fed policies. From day one, Fed officials have recognized that their experimental policies come with the risk of unintended consequences and even collateral damage. In signaling in August 2010 the beginning of QE2 -- a second round of bond-buying aimed at stimulating growth -- then-Chairman Ben Bernanke pointed to a “benefits, costs and risk” equation. The net impact becomes increasingly uncertain the longer the country relies on such extraordinary measures to address its economic ills. One big risk -- which officials may be hesitant to discuss openly -- is that such extended monetary stimulus will lead to financial instability, which in turn could undermine consumption and growth.

All told, I expect the minutes to portray a U.S. economy strong enough to withstand external headwinds, but still struggling to operate at full capacity and regain its longer-term potential. Although the Fed will stick to a cautious, measured and data-dependent approach, admitting that there are still areas of analytical uncertainty, this will not necessarily mean that it will signal inaction.

There's a growing recognition, at the Fed and elsewhere, that expectations of an even more prolonged period of ultra-low interest rates can undermine the integrity, soundness and effective operation of the financial system. Hence, the Fed will leave the door open for a rate increase in September, and open much wider for December -- in hopes that the country’s policy regime may move away from excessive reliance on the central bank toward a more comprehensive response including more balanced demand management measures, structural reforms to amplify the economy's dynamism, actions to address pockets of over-indebtedness and much better global coordination.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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